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LIQUIDATION. A GOOD SOAKING. PLENTY OF TEARS. It is real wet out there in the markets.

Aside from getting washed out to a new 12-year low, the Dow has five of its 30 members bobbing below $10, a level under which more than a fifth of Standard & Poor's 500 members reside.

Given all the known big-picture reasons for this drenching, does it makes sense to continue enabling the folks who make and sell umbrellas to force it to rain at will? The people with a stake in umbrella prices who are able to trigger a downpour are the traders who bid up credit-default swaps on individual companies, whether they own their debt or not, and short the stock.

In combination, these actions feed signals into the market that companies are at risk of default -- often true, sometimes not, never a certainty. The mix of ballooning CDS premiums and collapsing share prices is a factor that can force credit agencies to issue debt downgrades, make real creditors nervous and scare would-be "real money" buyers away from the shares and bonds of the affected companies.

This is all legal, thanks to a law a few years ago exempting CDS from "bucket shop" laws that ban gambling on security prices indirectly. And, as New York State Insurance Superintendent Eric Dinallo testified in Congress last week, one likely reason they aren't termed credit-default "insurance" is that using that term would trigger state regulation and higher capital requirements for the underwriters, making the swaps expensive hedging instruments.

These rumblings moved Mike O'Rourke, a strategist at brokerage BTIG, to remark, "Rightly or wrongly, don't be surprised if at some point, regulators start poking around looking for investors who paired short bets in the common shares with long bets on the CDS."

Theoretically, an unlimited amount of credit-default swaps can be written and bought on any issuer, and there are incentives for buyers to make companies look sickly. If an investor buys a troubled issuer's deeply discounted corporate debt that has little chance of trading again at face value, and then buys CDS as protection, the investor could essentially want the issuer to default so the swaps pay off to the max.

Says Tony Dwyer, a strategist at FTN Equity Capital Markets: "You have turned the buyer of stressed corporate debt from a buyer incentivized to make the company better and worth more, to a buyer with the goal of default. If the total cost of buying a bond and insuring it to par is less than par, it creates an arbitrage that ultimately destroys capital."

Before getting too far along with this argument, let's be clear that trading instruments and techniques are almost never themselves responsible for market declines.

The companies attacked most heartily by CDS traders also have impaired assets and/or opaque balance sheets understandably under suspicion.

I never thought the hasty and clumsily imposed partial ban on short-selling last year made any sense, theoretical or practical, for instance. Even the "uptick rule" that, until 2007, required traders to wait for a higher-priced trade to execute a short sale, wouldn't have prevented the market carnage. And the now-popular call to suspend mark-to-market accounting for financial firms strikes me as ill-conceived, mostly because the market simply wouldn't buy it and would go on targeting the same companies now viewed as vulnerable to more write-downs.

But curbing CDS purchases by investors with no other economic exposure to the company seems akin to the creation of baseball's infield-fly rule more than 100 years ago.

It was an imposition on the purity of the long-established rules of play, producing an out in certain situations without the fielders having to actively retire the batter. Yet, it was deemed necessary to prohibit a single specific tactic of trickery (an infielder intentionally dropping a pop fly with two or three men on base and fewer than two outs, so as to get an easy double- or triple-play).

It wouldn't be the first time this baseball rule was invoked to justify legal restraints on what formerly were considered general, unwritten principles of fair play, as the career of this recently deceased legal scholar makes clear (http://en.wikipedia.org/wiki/William_S._Stevens).

EVEN BEFORE THE S&P 500 TICKED to a new intraday low Friday at 666, in the same session GE shares hit a midday low of 6.66, small investors were plenty spooked.

The halving-and-then-some of the market value of U.S. stocks and the quite rare brushing of a 12-year low sent the bearish reading above 70% in the weekly American Association of Individual Investors poll. That was the most pessimistic showing in its almost 22-year history.

Bulls numbered a mere 18%. So the bear-bull differential hit its second-highest level ever, trailing only a reading in October 1990, recorded a week after that bear market's low. Heavy outflows of some $6 billion from stock funds last week also reflect the rampant anxiety.

However, professional sentiment, depending on how it is measured, isn't even back to the extreme panic readings of last fall, when the indexes were a good deal higher. Maybe this is because this decline has been relatively orderly, and the prolonged uncertainty has inured more folks to the pain -- or because fewer hedge funds are "trapped" in leveraged positions (as a class, hedgies were about flat in February). What is more, the bank panic now is mostly about the fate of the slivers of common equity value left at the most strapped firms, not (yet) about the very functioning of the system, as was the case last fall.

Could it be, too, that there are enough perceived ways to hide in, or profit from, this environment (CDS strategies, double-short exchange-traded funds, gold) to keep all hope from being abandoned?

With the indexes stretched so far below their trend, a bounce or better could happen on any excuse, or none. Investors are so hostile to any and all government efforts, and so blind to real improvements in credit markets, that any less-than-terrible news would probably draw bids. Yet bulls would prefer to see investment pros' attitudes stripped of any remaining equanimity.

Now, though, Home Depot shares have outperformed enough -- losing "only" 21% this year to Lowe's 37% -- that it could be time to bet on a reversal.

The reasons Home Depot has held up better are no mystery. It was earlier in hunkering down for a recession, closing its Expo centers and other stores. Lowe's management is viewed as growth-addicted and insufficiently resigned to the horrid consumer and housing conditions, refusing to meet all the Street's demands for slowed expansion. Home Depot, too, has a higher dividend yield, 4% to Lowe's 2%.

With the stock-price spread between the two recently at a two-year high, Lowe's is now the cheaper stock based on forecast earnings, market value per retail square foot and cash flow (though not free cash flow, where Home Depot retains an advantage).

A number of relative-value and spread-trading relationships have gotten out of whack in recent months, as leveraged arbitrage investors have been carried out of the arena. Yet betting on Lowe's to regain a bit of turf on Home Depot looks reasonably attractive.

MARKETS LIKE THIS FURNISH SMALL investors with certain advantages over professional money managers. The little guy doesn't need to worry about underperforming short-term index moves, and is under no external pressure to remain fully invested.

The retail flock is also free to play low-priced, stunted market-cap names with little Wall Street sponsorship or importance in any benchmark.

One such name that appears to offer plenty of value for those who can play small ball is
Alliance One International
(AOI), a processor and supplier of tobacco for the big cigarette makers. The stock is at 3.16, the market cap around $300 million, and only one sell-side analyst follows it.

After a ringing upside surprise in quarterly earnings reported last month, the stock is up a bunch from a Jan. 30 low of 2.40, but still trades at scarcely more than three times the $1 per share the company is projected to earn for the fiscal year ending March 31. This stark cheapness is related in part to its obscurity -- and its substantial debt load. AOI's net debt was $970 million at last quarter's end, a legacy of a merger with a competitor a few years ago. But the company has steadily paid down debt out of free cash flow. Half of the debt isn't due until at least 2012, and the rest is seasonal working-capital borrowings secured by tobacco inventories.

The stock remains largely in the hands of index funds that must own it, and quantitative managers whose black boxes seem to seize on its low price-to-book value ratio and its penchant for running like a startled cat, in either direction.

The stock's jumpiness and its low price place it in the not-for-the-fainthearted category. But in a market with elusive definitions of cheapness, AOI seems clearly to merit that designation.